Japan Banks Court U.s. Municipal Bonds

NEW YORK — Big Japanese banks have swiftly expanded in the field of credit enhancement for U.S. municipal bonds in the last few years while American banks have become wary of the business.

Japanese banks estimate that they may be covering half of the municipal issues that use bank credit enhancements and account for more than 10 percent of the tax exempt market.

Municipal bond issuers--cities, counties, states and agencies such as bridge and tunnel authorities--use enhancements such as bank letters of credit to increase the attractiveness of their securities to investors.

A letter of credit is a bank`s promise to pay debt service on securities under certain conditions if the issuer is unable or unwilling to do so.

By purchasing a letter of credit written by a highly rated bank, a bond issuer with a relatively poor rating can borrow money at interest rates less than those it would pay if it tried to sell securities without enhancements.

Most such letters also enhance liquidity with banks promising to purchase bonds for temporary holding if they are sold back to issuers and cannot be resold.

The New York offices of Japanese banks said they were extremely busy writing letters of credit late last year as issuers advanced many debt sales in anticipation of tax reform, which threatened the tax-exempt nature of some municipal securities after 1985. Interest earned on municipal bonds is exempt from federal income tax.

Last year`s municipal issues hit a record $228 billion, up from $121 billion in 1984, according to Salomon Brothers Inc. The investment banking firm said it expects this year`s volume to slip to about the 1984 level because of the rush to market late last year.

About 10 Japanese banks with triple-A ratings are writing letters of credit for American municipal bond issuers. Most of them started the business in 1984 after obtaining the ratings from the major credit reviewing agencies. The Japanese virtually replaced the major U.S. banks whose holding companies, except J.P. Morgan & Co., have lost the ratings because of their large exposure to foreign debt. The Federal Reserve Board also discourages U.S. banks from increasing off-balance liabilities resulting from the business.

Japanese banks also are offering letters of credit for lower fees than their American competitors find profitable.

Yutaka Komatsu, vice president and manager of Fuji Bank, said:

``Competition has been keen between Japanese banks.``

Municipal bond issuers have welcomed discounts in fees for writing letters of credit, said Masayasu Ueno, senior vice president of Sumitomo Bank`s New York Branch.

But he said the discounts have discouraged U.S. banks from doing the business.

``It doesn`t pay`` for American banks, said Aaron S. Gurwitz, Salomon`s vice president for bond research.

Bank of Tokyo spokesman Kiyoshi Tsunoda said he is concerned that Japanese, with discounts, could dominate the business, causing friction with American banks.

Sumitomo`s Ueno and some other Japanese bankers voiced similar concerns and stressed that they have taken a selective approach to the business.

Industrial Bank of Japan, the only Japanese bank that has triple-A ratings from Moody`s Investors Service Inc. and Standard & Poor`s Corp., the two largest rating agencies, has received a massive number of credit enhancement requests but has accepted only 20 percent, said Satoshi Hirosawa, senior manager of its New York Branch.

Yuko Oana, managing director of Dai-Ichi Kangyo Bank, the largest Japanese bank, said his bank strictly selects deals for high returns.

But Michitaka Motoda, senior vice president of Sanwa Bank, said the business, though associated with risks, is an easy money maker.

The banks offset some of the danger by inviting others into syndicates that share risks, and fees, on letters of credit in much the way securities underwriters bring issues to market.

A recent Salomon report noted that Japanese banks are increasingly active in letters of credit that back put option bonds.

These securities allow investors to put, or sell back, their bonds to the issuers at stated times. The bonds usually pay variable interest rates and investors can put them after a change if they are unsatisfied with the new return. Bank letters of credit provide funds to repurchase the bonds if they cannot be immediately resold to other investors.

Salomon`s report said put bonds accounted for more than 28 percent of municipal issues in 1985, up from 5 percent in 1983. It said more than half of such issues for the three years were backed by bank letters of credit.

This estimate covered put bonds worth $50 million or more, issued in the three years and puttable in 1986.

Gurwitz said most of bank credit enhancements are attached to put option bonds.

Katsuhiko Yamaguchi, senior vice president of Bank of Tokyo, said that 70 to 80 percent of his bank`s municipal credit enhancements are for put bonds.